The Overhead Myth

Thanks to friend and colleague Jeffrey Byrne, President + CEO of Jeffrey Byrne Associates, for addressing "The Overhead Myth" and allowing me to re-post. Confusing to donors, grantees and charities themselves  only  in recent months have knowledgeable leaders weighed in. Here are excerpts from his piece:

Last June (2013), three highly-respected nonprofit leaders asked donors in America to look beyond overhead and help dispel the "Overhead Myth." 

Jacob Harold, President and CEO of GuideStar, Ken Berger, President and CEO of Charity Navigator, and Art Taylor, President and CEO of BBB Wise Giving Alliance, launched an initiative to help donors make better decisions about their giving: by eradicating what they believe is a common misconception that, on its own, "overhead" is a valid and appropriate way to evaluate a nonprofit.

In an open letter to the donors of America, the most trusted and reputable organizations that provide information about nonprofits in America denounced the overhead ratio and asked for help in ending the "overhead myth." Donors were asked to take into account additional factors of a nonprofit's performance - such as transparency, governance, leadership and results - when evaluating charities and making their charitable giving decisions. 

More than 2,800 have signed the pledge to "end the Overhead Myth and help support nonprofits to invest in their mission, sustainability and success." But after an initial flurry of reaction and commentary, the "movement" seems to have quieted a bit. 

We all understand the overhead ratio (more commonly referred to as "overhead") is the common term used to describe the percentage of a charity's overall expenses allocated to administration and fundraising costs. We also know it is a commonly-accepted and often-used metric to assess a nonprofit's performance and worth. But many times, it is misinterpreted by foundations, major donors and corporations when used as the key tool in evaluating a nonprofit's organizational efficiency. Maintaining low overhead may also inhibit organizations from making investments necessary to achieve success.  To make matters worse, feeling pressure to present low (or in some instances, practically nonexistent) overhead, many nonprofits misrepresent or under-report this number - especially when it comes to fundraising expenses.  

Is this behavior truly in the best interests of either side - let alone the causes they each hope to support?  

THE MYTH

Though overhead does have a role in evaluating charities, focusing on overhead as the sole or primary determinant of a nonprofit’s effectiveness can have negative repercussions: if charities don’t direct resources toward sustaining and strengthening themselves, they will ultimately not be able to fulfill their missions or effectively help those they are trying to serve. 

Another concern is the way donors, funders and watchdog agencies utilize audited financial statements and publicly available IRS Forms 990 as part of their assessments: the proportion of total expenditures for administration and fundraising often receive particular scrutiny. But how accurate are the numbers reported?  If there are errors, what are the sources of the inaccuracies?  

NOT NEW 

Dr. Patrick Rooney, Associate Dean for Academic Affairs and Research at the Indiana University Lilly Family School of Philanthropy and one of the lead researchers in the Nonprofit Overhead Cost Project conducted in 2004* offers the caveat that obvious functional expense reporting errors occur even when the documents are prepared by auditors and CPAs. For example: reporting all salaries as program expenses and reporting no fundraising expenses despite the existence of fundraising staff; or not including the cost of the time top executives and senior program managers devote to securing government grants. Responding to pressure (both real and perceived), nonprofits have changed their behavior to keep real and reported administrative and fundraising costs low.

The authors of the Overhead Myth Letter back up both their claim and their call to action with statistics and research from several experts, including Indiana University, the Urban Institute and the Bridgespan Group. Dr. Gene Tempel, Founding Dean of the Indiana University Lilly Family School of Philanthropy, supported the Overhead Myth movement through his own open letter to the authors. Dr. Tempel expressed gratitude for their efforts and stressed the importance of continuing to educate donors and nonprofit executives about the best ways to evaluate nonprofit efficacy, instead of relying on one, over-simplified measure. Dr. Tempel also pointed out that overhead costs are “essential investments for effective, high-performing organizations.”

As Dr. Tempel says, “Donors and funders today want nonprofit organizations to do thoughtful planning, deliver effective programs through excellent management, and conduct effective fundraising and thorough evaluation . . . we have an ethical responsibility to get organizations to focus on accountability, transparency, and trust building.”